Forget global imbalances, it is now a Sino-American imbalance

Or perhaps a Sino-North Atlantic or Sino-Euramerican imbalance. Europe plays a supporting role in the drama.

If oil averages $50 or so this year and $60 or so next year – and if intra-European surpluses and deficits are netted out – the world’s macroeconomic imbalances reduce to the United States external deficit (which the IMF estimates will be under 3% of US GDP in 09), a somewhat smaller EU deficit and China’s 10% of GDP surplus.

On the surplus side of the global ledger, the IMF forecasts that there will soon be China – and almost no one else.

Stacking Europe on top of the US makes it hard to see Europe’s contribution to offsetting Asia’s surplus over the past two years. The US deficit peaked in 06; if Europe’s deficit hadn’t increased dramatically since then, Asia couldn’t have run such a large surplus (remember that from 06 on, most Asian currencies were deeply undervalued v Europe) at the same time as the oil exporters. Deficits and surpluses have to add up globally.

The IMF doesn’t current expect China’s stimulus to bring China’s current account surplus down. From a savings and investment view, I suspect the IMF expects a rise in public investment to offset a fall in private investment, not increase total investment – and the swing in the fiscal deficit to partially be offset by a rise in household savings. Just a guess though. And on the trade side, the fall in exports will be offset by the impact of lower commodity prices. The fact that China’s current account surplus is expected to stay large over time also suggests that the IMF continues to believe that the RMB is undervalued.

The bigger question though is whether or not China will still be willing to accumulate the very large claims on the world implied by the IMF’s forecast. China is already worried about the long-term value of its $2.3 trillion or so in reserves and hidden reserves.

The current account surpluses in the IMF’s forecast implies that Chinese claims on the world would rise by another $2.3 trillion over the next 4 years. If private Chinese savers don’t want to add to their dollar and euros, the government would need to resume buying – on a large scale.

One last point:

The IMF doesn’t attribute the current crisis directly to global imbalances. Fair enough. The proximate trigger for the global downturn was a collapse in private financial intermediation, not a collapse in net demand for US financial assets. It wasn’t linked to a dollar crisis — at least not directly (more on this later). The subprime crisis of August 07 proved bad for the dollar; but Lehman’s crisis unleashed a bout of deleveraging the supported the dollar. The US consumer – -and US financial sector — gave out before the rest of the world’s willingness to finance the US.

At the same time, as Martin Wolf and others have emphasized, the capital outflow from the emerging world to the US and Europe – a flow that was necessary to support large household deficits in a country like the US where neither the government nor business was savings – wasn’t a private flow. The scale of emerging market reserve growth was far far larger than ever in the past. And that includes the period immediately after the Asian crisis when a host of countries added to their reserves on a large scale.

I usually plot reserve growth with a positive sign. But an increase in reserves produces a capital outflow. Plotting the outflow from emerging market governments to the advanced economies over the past several years highlights just how much money emerging market governments moved into the financial markets of the advanced economies.*

Private investors in the emerging world didn’t, generally speaking, want dollars or euros. That is why reserve growth topped the emerging world’s current account surplus.

The IMF seems to expect a return to this pattern – just with a smaller number of players, smaller aggregate flows and smaller deficits in the US (scaled to GDP). China’s surplus would continue to fuel Chinese reserve growth and thus the buildup of Chinese government claims on the US and Europe. And, implicitly, China’s government would risk ever larger losses on its ever growing foreign portfolio – at least so long as China finances the world by buying dollars and euros, not making yuan-denominated loans.

* The IMF’s data includes SAMA but it excludes the Asian NIEs (Korea, Taiwan, Singapore and HK) and leaves out China’s non-reserve foreign assets. It thus understates headline emerging market reserve growth. On the other hand, I am not sure if it is adjusted for valuation effects, so it may overstate reserve growth when the dollar is falling.

10 Responses to "Forget global imbalances, it is now a Sino-American imbalance"

Anonymous April 24, 2009 at 11:35 am

botom line: we should be looking for Chinese classes for our kids?

Jean-Philippe Thiébaud April 28, 2009 at 11:12 am

It would be easier to call that great imbalance a Western – Eastern imbalance, which it is.

Guest May 1, 2009 at 10:23 pm

Excellent article!!!!”not sure if it is adjusted for valuation effects, so it may overstate reserve growth when the dollar is falling.” important notationRegonomics at its best, consequence of 1984, and it passed right by economists and congress, they didnt even know what hit them, in fact President of the American Economic Association at that time, made claims that it would even out, in the end, and this supported Treasury Secretary to ignore looking at the consequences. Dangerous when congress doesnt pay attention, and when execs make stupid decisions.well,We can go green first and sell it to China so they can spend their reserves.We can advance medical technology faster and then charge China.But its not like they are not effected by the recession, did you hear 70,000 manufacturing facilities closed last year in China, they couldnt get funding from cfo.com.”More than 20 million workers, or 15 percent of the total Chinese labor force, had lost their jobs as export-oriented factories shut their gates (in 2008). “http://www.lancastereaglegazette.com/article/20090414/OPINION02/904140327China has to have some reserves, when those 40 million men retire/ with no wives or kids, what is China going to do? give them opium?It was an American deal that resulted in Chinese surplus, it can be an American deal that can get America back to #1.

Guest May 5, 2009 at 11:14 pm

But its not like China is not effected by the recession, did you hear 70,000 manufacturing facilities closed last year in China, they couldnt get funding— that is from an article on cfo.com about CISCO risk management.Ironic, there is an add about Replica watches,

Guest May 5, 2009 at 11:17 pm

that comment about letting 70,000 manufacturers close, because lack of ability to secure financing, losing 15% of the labor force signifies they are very frugal with spending.

Guest May 6, 2009 at 2:44 pm

Here is a blip in the media that you might like:RPT-TAKE-A-LOOK-Foreign funds flow back to Asia on China hopesTue May 5, 2009 5:33am EDTAfter a six-month drought, foreign investors have beensending billions of dollars back to Asia, a trend some expectto continue on hopes China will lead the region out of theglobal recession.Foreigners have poured a net $6 billion into six majorAsian markets since early March, according to BNP Paribas,helping to boost China, Taiwan and South Korea stocks by up to35 percent this year and making them the world’s bestperformers.